Opinion: The case for buying Chipotle (both the guac and the stock)

It’s not often that investors get a chance to buy a great brand at a serious discount — let alone a second chance.

But that’s exactly what you’re getting with Chipotle Mexican Grill Inc.
CMG, +0.58%
Take advantage. (And get some free guacamole and chips.) The burrito-chain’s stock just took another hit, and you should tuck away some Chipotle shares for a few years. You will be rewarded nicely, with a stock that outperforms the market as the eatery recovers from its woes. I’ll explain why, but first a quick recap.

Chipotle shares got hit hard last fall on health concerns following E. coli and norovirus outbreaks. The stock got knocked down as low as $400 in January, from $750 in October.

Then it snapped back. By early March, the stock advanced over 30% from where I last suggested it on Jan. 13, rising to $530-$540.

Recently, the burrito-chain’s stock got hammered yet again by another double whammy.

2. The chain also got linked to another norovirus outbreak near Boston.

The best thing to do now, other than take advantage of the short lines, is to hold your breath and buy some stock. Here’s are five reasons why.

Reason 1: People aren’t really that concerned about health issues at Chipotle

This sounds like an audacious comment. After all, how would I know? Well, I’ll tell you. Back in February, the chain shut down for a lunchtime “town meeting” with all employees. Signs on the doors offered customers mobile-delivered rain checks for a free lunch. Naturally, the offer went viral.

What happened next is all you need to know. The request rate was insane. Chipotle expected 2.5 million rain-check requests. But 5.3 million people responded in around five hours. That works out to around 17,000 per minute. Then, 67% of those people redeemed their coupons. That’s an “extraordinarily high number” for this kind of offer, Chipotle’s chief creative and development officer, Mark Crumpacker, told investors at a meeting March 16.

The bottom line here is that if anyone were seriously worried about Chipotle’s health risks, they wouldn’t abandon their concerns for a mere $8-10 — the value of the free food offer. Think of it this way: Suppose you had reliable information that the Titanic was going to sink. You wouldn’t change your mind and board anyway, just because someone gave you a $10 discount on the ticket.

Still, traffic is way below normal. What will it take — other than free offers that can’t go on forever — for people to overcome their hesitancy? History tells us it’s just a matter of time. Restaurant chains typically recover fully from food scares in about a year.

But there will be more free offers. Chipotle has been sending out coupons via snail mail, and it will offer “buy one get one free” deals this summer.

Reason 2: Sales are already recovering

You wouldn’t know this from the recent stock decline. But it’s true. At the low point this year, in the third week of January, comparable-store sales were down 40%. By the first week of March, that sales decline slowed to 21.5%. Then the Boston-area norovirus news hit March 8, reversing some of the gains.

That was a setback. But the pre-Boston gains had Chipotle cutting its losses by around 50%, which put it ahead of the game. According to Wells Fargo Securities analyst Jeff Farmer, from their worst levels, food safety-related sales declines are cut in half within six months. Chipotle did it in about six weeks.

“The recovery we have seen, excluding this incident in Boston, is exactly what we were looking for,” Crumpacker said.

Clearly, the free offer helped. As redemptions trailed off, customers kept coming back anyway and purchases picked up, Chipotle said. This is confirmed by research by Farmer, at Wells Fargo Securities. His team staked out Chipotles in Boston, Chicago, New York and San Francisco for weeks after the Feb. 8 rain-check offer ended. Their mission was to count lunch lines at the same time each day. They found line counts hung in at around 80%.

“We built a long established, trusted relationship with our customers. And while that trust was questioned recently, we are delighted to see they are retuning in large numbers,” Chipotle co-CEO Steve Ells said at a March 16 meeting with investors.

Reason 3: The big margin hit and first-quarter losses will reverse

Investors were rightly surprised in mid-March when the company announced an unexpected sharp decline in first-quarter margins, and the estimated loss of $1 per share. But drill down on what caused margins to narrow, and you can see it’s sort of understandable — and likely to go away.

After all, Chipotle is in new territory. So a lot of things are tough to predict. Indeed, because of unpredictable customer traffic, Chipotle found itself overstaffed at times during the quarter. It was also overstocked. So food wastage was up. There was also food waste from testing.

Then there were the promotional costs, compounded by an accounting twist. Chipotle sent out coupons by snail mail, with expiration dates that run well into the second quarter, or the middle of May. But accounting rules dictate it must deduct the expected cost of the coupons in the first quarter since that’s when they were mailed.

As the chain gets on a more even keel, most or all of these additional costs will go away and margins will widen.

Reason 4: Chipotle’s safety protocols seem to be working

Chipotle caught some bad press after it closed a store once again for health reasons on March 8. This time it was in Billerica, near Boston, because employees came down with norovirus. But it’s not a stretch to turn this story around and cite it is an example of how Chipotle’s health protocols actually work well.

Chipotle tells workers to stay home if they are sick, and it pays them to do so. In Billerica, four workers called in sick and stayed home. They never worked after getting sick, the company said.

“No customers were affected,” Ells said.

But the company closed and cleaned the restaurant, presumably just to be safe. This sounds like about how it should go when employees get sick, which is inevitable.

Given that there are 22 million cases of norovirus in the U.S. each year, more cases of employees calling in sick with the disease might pop up. But we won’t necessarily hear about them. Chipotle is not required to report them to health officials. The Boston-area case leaked because a parent of one of the workers went public.

Reason 5: Chipotle has decent long-term prospects

Lost in all the health concerns is the fact that Chipotle has a lot of room to grow. It can still more than double in size. Chipotle has about 2,000 restaurants, but it has the potential to operate 5,000 in the U.S. and more abroad, says Baird Equity Research analyst David Tarantino.

At the time of publication, Michael Brush held shares of CMG.. Brush has suggested CMG in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.

Michael
Brush

Michael Brush is a Manhattan-based financial writer who publishes the stock newsletter Brush Up on Stocks. Brush has covered business for the New York Times and The Economist group. He attended Columbia Business School in the Knight-Bagehot program.

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